Synthetic Short Call : Similar Payoff Profile To Short Call

Introduction To Synthetic Short Call

A synthetic short call is an artificially created trade that has a payoff diagram that is similar to a short call. The payoff of a synthetic short call is such that when the price of the underlying security declines slightly or stagnates, the trader will earn a maximum profit. Please refer to the payoff diagram shown in this article.

The options trader should look for tell tale signs in the economy and the fundamentals of the underlying that the markets are slightly bearish. Some of the chart patterns that option traders should look out for are:

The trader who executes a synthetic short call is anticipating a stagnation or slight decline in the price of the underlying security such that the put option employed expire worthless. When that happens, the trader earns a maximum but limited profit.

After the maximum profit is calculated, the trader should also calculate the risk involved when stop loss is in place. Next, the trader should calculate the risk and reward ratio. This will help a trader determine the attractiveness of the trader when compared to another trade of a similar nature.